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| R Ravimohan: India should grow within its means |
| R Ravimohan / New Delhi Oct 13, 2008, 00:25 IST |
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Markets are still eager to finance firms which hold low debt and good quality assets on their books. It also does not hurt to have a good source of external finance which increases financial flexibility during exigencies, says R Ravimohan
The financial markets and the economy in many parts of the world are hurting, while the Indian economy continues to show a robust positive growth trend and its financial system appears to be in a relatively strong position. How should Indian business and policymakers deal with this dichotomy? Should they march ahead with their ambitious growth strategy and continue investing in the development of the Indian economy and markets? Or should they tighten their belts and ride out this uncertain phase and resume their growth agenda after the world settles down? The steep premium that the markets are asking to part with cash appears to outweigh the payoffs from decent growth prospects in the medium term. Therefore, it appears prudent for the time being to tighten the belt and grow within one’s means, even if it means slower growth. This certainly is a good time to be safe than sorry.
The Indian economy grew on the back of both consumer drive and investment buoyancy. In the next few quarters, demand is likely to temper, bowing to the pressures of heightened inflation, uncertainties caused by the global turmoil, shrinking supply of consumer finance and increased interest rates, countering the continued buoyancy of rising income and employment levels in a service-dominated economy. More emphatically, investments are expected to slow down, given the lower projected demand-supply gap, tightness in the Indian financial system and difficulties in global financial markets. In both the global and Indian systems, better credits still get the funds they require, albeit at a higher cost. The lower end of the credit spectrum just cannot get any funds from formal financial sources and is scourging the informal system.
At these times where credit is appraised under the shadow of the worst credit distress faced in the markets in recent times, there is as much play for fundamentals as for a return to conservative nuances. Three important elements in getting assessed as good credit in current times are low gearing, good and clearly understandable assets and a visible support system which can add to the entity’s financing flexibility in the event of contingencies. From the extreme of building structures of high leverage, the financial system now looks to taking the most conservative view of both accounting practices and norms. For instance, the leverage is now calculated after consolidating all related parties and discounting all ‘non-real’ accrued or revalued reserves. Similarly, on the asset side, the market prefers to see assets that have been around for sometime and which carry a historic value. It becomes very difficult to put a value on the new-age assets, especially structured assets and derivative assets, which have a relatively short history and whose valuation conundrum lies at the root cause of this crisis. If all this is taken together, staid, real sector companies seem to score better than new fangled companies that grew rapidly into new areas in the past few years. This is not to say that all new asset classes are necessarily bad, just that the market is finding it difficult to put a value to it and hence, is less enthusiastic about lending money against such assets.
Even for those good credits, the finance costs are higher now than a few months before. This is because the number of financing sources has reduced (as the global financial markets are consolidating), and also, the cost of the financiers themselves has gone up substantially. This situation is unlikely to be corrected for some years to come, as the financiers will contend with tighter regulations and higher provisions for the losses suffered in the recent turmoil. Therefore, a good strategy for raising funds would be to diversify as many sources as possible, by casting a worldwide net. This reduces the dose of exposure to any single source and induces competition among different sources.
The other thrust of the strategy is to try and access pools of savings directly through public markets, bypassing the wounded financial intermediates for the time being till they recoup their lost strength — somewhat like the Dhirubhai syndrome of the late ’80s and ’90s where Reliance began to access public markets rather than depend on traditional banking sources. Good credible businesses should be able to access money as there are still large communities of global savers and investors who are seeking to find good, safe and viable investment opportunities. While a large proportion of the investment community has suffered, one important feature of the global financial markets now as compared to any other time in history is the huge size of the financial assets as compared to the real sector assets. It is currently estimated that the value of financial assets is over three times the value of the real GDP of the world (down from 4.5 times at the peak).
Entities that face one of the above mentioned issues would be well-advised to correct the situation as rapidly as they can to make themselves credit-worthy. These corrective measures might include de-leveraging the balance sheet, either by getting debt light and better capitalised, or by offloading assets that carry higher risk perceptions. Admittedly, this is not the best time to sell assets, as valuations have dropped, nor to raise capital when premium have tapered, but it is the sensible approach at this stage when financial markets have dislocated so badly. This correction will also clear the deck for companies to resume their investment for a growth strategy earlier than later. As observed earlier, the fundamental portents still point to a robust long-term growth, and hence companies need to not only adopt strategies to address the immediate issues, but also come out of this difficult period strongly positioned to resume longer-term growth prospects.
Policymakers and regulators have begun to loosen constraints in the market in the recent past to provide increased flexibility to players. It will be important to continue this good work for the remaining few constraints, such as allowing foreign debt capital flow into India to help fund raising and corporate restructuring. Another area that will really help accelerate restructuring is to lower stamp duty and transaction levies on restructuring and mergers and acquisition initiatives. While this bout of relaxation in market access is truly welcome, it might also be important for policymakers and regulators to desist from closing and opening markets as a means of stabilising them. It is not clear whether such precipitous moves achieve more than the harm leaving the market always tentative and unsure causes, resulting in sub-optimal investment and long-term interest developing in these markets.
The author is the Managing Director & Regional Head of Standard & Poor’s, South Asia. The views expressed n this article are personal. He can be contacted at r_ravimohan@standardandpoors.com
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